Attractive Medium-Term Cash Generation Prospects for BAE Systems; FVE Unchanged

Wide-moat BAE Systems experienced good growth in order intake for 2020, at 13%, bringing the group’s backlog to GBP 45 billion. Free cash flow of GBP 1.4 billion, excluding the GBP 1 billion one-off pension contribution, was a solid 60% increase over the previous year, well ahead of management’s GBP 800 million guidance at the first-half results. Revenue growth of 4% was accompanied by EBITA growth of 0.7%, hampered by underrecoveries in the defense business and lower demand from the group’s commercial businesses. Management is guiding for 2021 midpoint revenue and EBITA growth of 4% and 7%, respectively, while targeting GBP 4 billion of cumulative free cash flow (about 25% of current market value) over the next three years. The group’s broad exposure to platforms and geographies allows for stable and predictable cash flows underpinned by resilient defense demand and long-term multidecade contracts. We don’t expect to make any major changes to our GBX 570/$30 fair value estimate, which still reflects decent upside. A relatively secure dividend yield of 4.7% makes the stock particularly attractive to income investors.